From financial management to sales, every business operation is paramount. Similarly, ensuring that the enterprise keeps thriving uninterruptedly also needs attention. Business leaders leverage their expertise to bring maximum returns, but they will only stay for a while. Unplanned events such as the business owner’s death can bring turmoil to the business.
It is wise to purchase buy-sell agreements to avoid any turbulence. As a business owner, you need a clearer understanding of every facet when preparing for them. Here, you will learn about creating a buy-sell agreement with multiple partners.
The Buy-Sell Agreement for your Busines
A buy-sell agreement is a legally binding document that stipulates the continuation of a business after the death of an owner. There are two significant kinds of arrangements you can prepare:
The Cross-Purchase Agreement:
This arrangement allows the owners to buy and own the life insurance for the other stockholders. Every owner will be the beneficiary and pay for the premiums as well. The amount of insurance will depend on the interest of the ownership. If one owner dies, the proceeds will buy their interest from their family or estate. It can be an unwieldy plan if there are more than two owners.
The Entity Purchase Agreement:
In it, the business buys the entire interest of an owner at a predecided cost and following a triggering event. It is also known as liquidation of interest in the scenarios of partnership. In the case of using life or disability insurance, the business is both the beneficiary and the owner of the policy. It can use the proceeds to invest in the late partner’s stock following the death or disability.
The emphasis here is on learning about entity purchase agreements:
Using Entity Purchase Buy-Sell agreement with Multiple Partnerships
This buy-sell agreement is efficient with around four to five owners. The occurrence of purchase and sale happens among withdrawing owners and corporations only. To avail of it, you need to be a co-owner of the business, which has to be a partnership, S corporation, C corporation, or professional corporation with a small group of owners.
You can find these forms of agreements easier to convert into cash. The business owners from closely-held businesses reinvest their profits in their firms. This results in rising business assets but reduces the investment cash they can use for stock purchases. In this form of the buy-sell agreement, the business owners are not responsible for putting in the funds needed for the arrangement. The business instead invests money to purchase the buy-sell agreement.
Investing in the Life Insurance Policy for the Buy-Sell Agreement
Irrespective of this kind of buy-sell agreement, the business can use the life insurance policy to fund a buy-sell agreement. In that scenario, either the owners or the organization purchase the policies of other owners. Upon the death of a partner, the policy owners get the death benefits from the policies they had invested in. The deceased partner’s family receives the money in exchange for their interest in the business. The business gets the ownership, while the family receives the finances in exchange for it. There are different scenarios to analyze this form of funding.
Here are the advantages of using life insurance to invest in a buy-sell agreement:
- It provides the business and its owners with lump sum money they can use to finance the agreement.
- It allows them to use the proceeds faster as the takings are available quickly after the death.
- If the policies provide enough built-in insurance benefits, the business can leverage funds to purchase your business interest after any disability or retirement.
- In most cases, proceeds from life insurance are tax-free. It is for C corporations that they might have to pay alternate minimum tax or AMT.
Disadvantages of using life insurance policies:
There are different advantages to using a life insurance policy as a fund for buy-sell agreements. There are also disadvantages you have to deal with:
- As premiums do not fall under a tax-deductible expense, you may get life insurance premiums with after-tax dollars.
- You will have to pay premiums which are recurring expenses.
- Depending on the ownership percentage, you will have to pay more insurance for owners having a more significant interest in the business.
- As to the factors like age and disease, there can be partners who cannot be insured.
Using Group Life Insurance to Fund a Buy-Sell Agreement
The term group life insurance refers to insurance covering a specified group of people. However, premiums from this are tax-deductible for this life insurance, but not in cases with a business being a beneficiary. In the case of a buy-sell agreement, this can be an alternative thought, but it is generally not an advised one.
Ensuring continuity is a must-have for any business, but that is more than just the intricacies of creating buy-sell agreements. Purchasing the life insurance policy to finance it is another task. It is where you can need the assistance of professionals in finances. At Lions Financial, we are a team of experienced professionals you can count on to select the type of Risk Management planning to coordinate with your buy-sell agreement suiting your business structure. We can get you a clearer picture of the plans that can benefit your business in the long term.